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Target-Date Funds for Retirement

Twenty years ago, no one had even heard of a target-date retirement fund. By 2020, less than 10 years from now, they’ll make up half of the $7.7 trillion in 401(k) and other defined-contribution retirement plans, according to consulting firm Casey, Quirk & Associates.

For the uninitiated, target-date funds (TDFs) are marketed as a set-it-and-forget-it retirement solution. You put your money into a fund with a date in its name that’s in line with the year you think you’ll retire. Over time these funds reduce their overall risk by dialing down their stock holdings and increasing their fixed-income ones. Result: the closer the target date, the more conservative the portfolio becomes.

These funds have always had a lot going for them. They save investors the hassle of picking individual funds, as well as the pain of rebalancing. Unfortunately, the perception going into the crash of 2008 was that they would prevent you from losing money as you closed in on your retirement date. That they did not do.

When the average 2010 TDF lost 24 percent in 2008, investors went screaming to their benefits departments and to the press. A Senate investigation and government hearings followed. Charles Schwab, Fidelity, and a number of other fund companies tweaked their portfolios to lower expenses (always a good thing); many reduced their equity exposure as well, says Craig Copeland of the Employee Benefit Research Institute. Now, if you’re among the millions going the TDF route, how can you protect yourself as you close in on retirement?

Step one is understanding what you own. That’s more complicated than just knowing what a TDF is. You need to understand what’s in yours, how the investment mix will change over time, and where you’ll land around age 65. Most funds start with around 90 percent in equities for a 25-year-old, explains Lori Lucas of Callan Associates. After that, some have a dramatic decline and others don’t. As most 401(k) participants are offered only one family of TDFs, if you’re not happy with the risk, adjusting the year is the solution. If you’re retiring in 2040, a 2030 fund will be more conservative, a 2050 more aggressive.

The other important thing to know is when your fund hits its “landing point,” or most conservative position. Is it at the “target date” in the name or 20 or 30 years down the road? For many funds it’s the latter, explains Joseph C. Nagengast of the research firm Target Date Analytics. “There’s no justification for that,” he says. “Right now, 60 percent of funds are misleading.” Despite this, he believes the prevalence of TDFs is a good thing. “Most do a better job of managing participant portfolios than participants left on their own,” he says.